Using Breakeven Analysis To Make Decisions Flashcards
Contribution example, variable costs of making a candle = 15p candle selling price = 38p
38p- 15p = 23p
Total contribution definition
The difference between sales revenue and total variable costs
If total contribution is greater than fixed costs..
The business makes a profit
If total contribution is less than fixed costs…
The business makes a loss
Total contribution calculations=
Total contribution= contribution per unit x no of units sold
Total contribution= sales revenue - total variable costs
Annual profit =
Total contribution - fixed costs
Breakeven analysis definition
Study of the relationship between total costs and total revenue to identify the output at which a business breaks even (makes neither a profit not a loss)
Breakeven analysis makes the following assumptions
The selling price per unit stays the same, regardless of the number of units sold
Fixed costs remain the same, regardless of the number of units of output
Variable costs per unit stay the same, regardless of output
Every unit of output that is produced is sold
Break even output definition
The level of output at which total revenue is equal to total costs of production
Break even output =
Fixed costs
—————-
Contribution per unit
Margin of safety definition
Difference between the actual output and the break even output
Margin of safety =
Actual output - break even output eg
12,000-4,000 = 8,000
Break even analysis is useful to a new business in many ways:
A new firm can use it to calculate how long it will take to reach the level of output needed to make a profit
Business can predict it’s likely profit level
A simple straightforward way of discovering whether a business plan is likely to succeed financially
Useful to plan expected results eg best case scenario and worst case scenario
Calculations quick and easy to complete saving business time
Weaknesses of break even analysis
Information may be unreliable
The assumption that sales will equal output, likely that some output will remain unsold
The selling price may change as more is bought and sold
Fixed costs may not stay the same as output changes new buildings etc may need to be purchased
Analysis assumes that variable costs per unit are always the same, ignoring factors such as buying in bulk
Contribution per unit=
Selling price per unit - variable cost per unit
